How California Cap-and-Trade Works — and How Newsom Wants to Change It

Gov. Gavin Newsom’s proposal to reauthorize California’s cap-and-trade program has kicked off high-stakes negotiations over the state’s landmark climate initiative.

Cap-and-trade, which Newsom proposed renaming Cap-and-Invest last week, limits greenhouse gas emissions and raises billions of dollars annually through auctions where companies buy credits that allow them to pollute. But the system has come under fire, from both President Donald Trump — who targeted the program in an executive order last month — as well as progressives who argue it hasn’t been strict enough on oil and gas companies.

Extending cap-and-trade, which sunsets in 2030, raises key questions for state leaders: Should money raised from the program pay for environmentally-friendly projects or help Californians manage the mounting costs of climate change? Will key decisions about the emissions cap be made by state lawmakers, many of whom are just learning the intricacies of the program, or by unelected state regulators with deeper expertise?

And how can the state balance global climate leadership by improving the air and water quality in communities located near major sources of pollution?

Here’s a primer on the program and what’s at stake:

How does cap-and-trade work? 

About three-quarters of California’s greenhouse gas emissions come from sources covered under cap-and-trade, including oil refineries, steel and paper factories, electricity generators and cement plants.

Every year, the California Air Resources Board sets a limit on carbon emissions for polluters. This “cap” decreases annually, helping the state meet its ambitious greenhouse gas reduction goal of lowering emissions to 40% below 1990 levels by 2030 and 85% below 1990 levels by 2045.

CARB then issues a number of tickets to pollute, known as allowances, equal to the cap. A little less than half of the allowances, around 46%, are sold to companies at auctions held four times a year. Roughly 37% are given to utilities such as PG&E, which are required to sell the allowances at auction and return most of the proceeds to ratepayers.

Finally, about 15% are given to companies for free to help them comply with the law and prevent them from going out of business or leaving the state.

Businesses can reduce emissions, use allowances to legally pollute or, in limited cases, pay for an emission-reduction project known as an “offset,” such as paying forest owners not to cut down trees.

Where does the money raised through cap-and-trade go? 

Revenue from the quarterly auctions goes to the state’s Greenhouse Gas Reduction Fund, or GGRF. Since its inception, cap-and-trade has brought $31.4 billion to the GGRF.

As the cap on emissions declines over time, allowance prices are expected to rise, adding more money to the fund. The Legislative Analyst’s Office estimates that the total value of allowances from 2030 to 2045 could reach $260 billion.

The single largest recipient is California’s high-speed rail program, which receives 25% of the revenue.

Another 20% is spent on building affordable housing near transit and 15% funds local transit. The remaining 40% pays for a variety of programs, including providing safe drinking water and forest management.

Then, there are the free allowances that utilities are required to auction off. Most of the proceeds pay for the California Climate Credit, a twice-annual credit on ratepayers’ bills — $58.23 for PG&E customers this April and October.

Does cap-and-trade regulate local air pollution? 

Not directly. The program allows businesses to decide how and, crucially, where to reduce carbon emissions.

Assembly Bill 617, which passed as part of the last cap-and-trade authorization in 2017, gave air regulators and residents new tools to reduce the release of particulate matter and air toxins in impacted communities such as West Oakland and Richmond.

In a letter written last month to legislative leaders, a coalition of environmental justice organizations said AB 617 had not delivered on promised improvements.

“Design flaws and lack of clarity in the legislation means that environmental justice communities are still waiting for the air pollution reductions they were promised,” the groups wrote. “The Legislature should strengthen AB 617 by improving accountability, community voice and funding, as well as the statewide pollution controls required in the program.”

What changes is Gov. Newsom proposing to cap-and-trade? 

Newsom is not advocating for any major alterations to the design of the program as he seeks to extend cap-and-trade to 2045. A Newsom spokesperson said he “is focused on the program’s stability in an increasingly uncertain world.”

Newsom is seeking to change where cap-and-trade revenues are spent.

The governor is proposing to set aside $1.5 billion — it could grow to $1.9 billion by the 2029–30 fiscal year — from the GGRF to pay for Cal Fire, which Newsom billed Wednesday as a way to direct money paid by carbon polluters toward fighting fires made more powerful by climate change.

“We think it’s more appropriate that the impacts related to the burning of fossil fuels — those impacts that come through the cap-and-trade program that are intended to be mitigated — that those impacts are having a direct result on the investments we need to make,” he said.

Lawmakers on Thursday expressed some skepticism over the idea of paying for state firefighting with fluctuating auction revenue. But far sharper opposition could come in response to Newsom’s doubling down on his commitment to the construction of a high-speed rail line.

While not officially in his budget plan, Newsom said last week he would ask the Legislature to set aside $1 billion each year from the GGRF for high-speed rail, allowing project planners to borrow against a fixed appropriation.

In a Thursday budget hearing, Assemblymember Cottie Petrie-Norris (D-Irvine) said the High-Speed Rail Authority would need to show a plan to move the beleaguered project forward before receiving a guaranteed cash flow from the GGRF.

“I don’t think you are going to get … the Legislature just writing you a blank check because [the High-Speed Rail Authority] tells us, ‘Don’t worry, trust us, this time it’s different,’” she added.

How do state legislators want to see the program changed? 

Lawmakers haven’t yet released plans for a reauthorization of cap-and-trade.

Some support Newsom’s “clean” authorization proposal that grants CARB flexibility. Others want to write changes into law, as questions over the program’s price ceiling and free allowances will have trickle-down effects for gas and electricity prices.

“Certainly over my last decade in the Assembly, we’ve heard some frustration with the Air Resources Board, that the Legislature has not very much input except at times when we were reauthorizing,” Assemblymember Jacqui Irwin, D-Thousand Oaks, said. “This is a program that is going to be with us for the next 15 to 20 years, and I think it’s really important to take a deep look and make sure the Legislature has input.”

On the spending side, lawmakers have discussed a handful of ideas to use cap-and-trade revenue to put more money back into the pockets of Californians.

That could include using auction proceeds to increase the Climate Credit on utility bills, upgrade utility equipment to reduce wildfire risk — a major driver of electricity rates — or provide subsidies for homeowners insurance, which have risen due to wildfires.

“There is not enough money to do high-speed rail, to do transmission infrastructure upgrades, to pay for wildfire costs, to pay for insurance reform, to do all of the big ideas I hear out there,” said University of Pennsylvania senior fellow Danny Cullenward, at a Senate hearing earlier this month.